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January 23, 2012

EU Seeks to Close Bank Capital Loophole

Sovereign debt not without risk, chairwoman says

The European Union will try to close a loophole that allows lenders to avoid holding sufficient capital to offset the risk on their holdings of sovereign debt, and the chairwoman of the European Parliament’s economic and monetary affairs committee said that such debt was not without risk.

Bloomberg reported Monday that two members of the committee said that while it will discuss changing the rules to be sure that lenders carry enough reserve capital to cover the risks of the sovereign bonds they hold, the new measures should not be implemented until after present market difficulties to ensure they do not make matters worse.

Sharon Bowles, chairwoman of the committee, was quoted saying, “I don’t think anyone is zero risk. We should dispense with the concept. It can maybe be the case that you don’t have to hold capital in certain circumstances. It’s just using this terminology turns us into idiots.”

The committee will consider the zero-risk rating on Tuesday as part of an overall debate on proposals for the implementation of bank rules that have been drafted by the EU’s Basel Committee on Banking Supervision.

The economic crisis has disabused officials of the notion that sovereign debt carries zero risk, as the survival of the euro itself hangs in the balance. Austrian lawmaker Othmar Karas, in charge of drafting the Parliament’s response to the proposals under discussion, was quoted saying, “I am convinced that the zero risk-weight does not correspond with the economic reality any longer.”

Karas said that regulators should overhaul a minimum liquidity rule for banks that was drawn up in Basel. The so-called liquidity coverage ratio would require lenders to hold enough easy-to-sell assets to survive a 30-day period of tight credit, but has been criticized by banks for being focused too much on sovereign debt. Karas added that the definition of such assets should be expanded to include gold and some equities.

While the action that can be taken right away is limited by the present economic crisis, say both Karas and Bowles, Karas’ draft proposal includes calls for the European Commission, the executive arm of the EU, to create options for eliminating the zero weighting “as soon as possible, while taking into account potentially destabilizing effects” of making such proposals “during periods of market stress.”

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